Is the Flash Crash Still Scaring Your Clients Out Of The Markets?

Executive Summary

Today is October 19, 2011. It is the 23rd anniversary of the Black Monday stock market crash of 1987, and in a few months we will "celebrate" the 6-month anniversary of the May 6, 2010 Flash Crash. With our recent obsession about crashes, I’ve begun to wonder: what is it about market crashes that scares us so much?

My focus on crashes today – the 23rd anniversary of Black Monday, and the nearly-6-month anniversary of the Flash Crash – is inspired in part by a chart I am seeing more and more of lately. A version of the chart, posted earlier this week on the blog Zero Hedge, indicates that retail investors have been pulling money out of the stock markets every week since our almost-crash (or whatever you want to call it) in May; this latest week was the 23rd consecutive that showed net outflows from equity mutual funds, and the total outflows now exceed $80 billion. The general conclusion that’s repeatedly being drawn: retail investors got "spooked" by the Flash Crash in May and as a result, have been pulling money out of the markets ever since.

This got me thinking a little… and my first thought was, "really?" Are we really suggesting that investors in October are "still" making decisions to sell their equity mutual funds because of the Flash Crash? Or alternatively (since the amounts reported above are based on net outflows), redemptions continue to occur but investors are choosing to buy fewer equity mutual funds due to the Flash Crash? Planners, are you hearing this from your clients? Because I have to admit, I don’t hear very many conversations that begin with "Well, I’d like to increase my equity exposure, but I’m still nervous about that crazy 1,000 point swing in the stock market 6 months ago."

And in point of fact, if we’re going to draw a parallel with what happened the last time we had a major crash, it’s notable that when the market crashed on Black Monday by 22.6%, with the Dow finishing at 1,738, it was already up to 1,999 after 6 months (on April 19, 1988). In other words, with that crash, we saw a 15% rebound within 6 months; this time around, the rebound hasn’t even been 5% from the Flash Crash close on the Dow of 10,520 to today’s level of approximately 11,000 (and it hasn’t quite been 6 months yet). In other words, if we can rebound 15% in 6 months from a 22.6% crash, why have we rebounded only 1/3rd of that after the mini-crash?

My impression is that the big difference between the markets of 1987 and the markets of today is the level of uncertainty. Not just a fear of uncertainty in the markets going forward, but an overall fear of uncertainty in the direction of the economy. It appears to me that investors are nervous not because of what happened in the past, but because of what they fear could happen in the future. And I think it is that persistent (and dare I say, growing?) awareness of our economic uncertainty that is contributing to equity outflows, far more than remembering an admittedly ultra-volatile intra-day market event that occurred on one particular day 6 months ago.

Of course, I’m sure that the big equity outflow that particular week of the Flash Crash was absolutely due to a short-term panic about the markets. But in our investing world that forgets oh-too-quickly, I just don’t believe that today’s outflows are still attributable to May’s Flash Crash. For better or for worse, I think most clients have already forgotten about the Flash Crash and most of its details (except to the extent that they were reminded by recent media coverage of the regulatory analysis of the causes of the Flash Crash). I think clients feel fearful and scared because of today’s uncertainty regarding the economic environment; the uncertainty of job security, house prices, portfolio prices, taxation, our country’s financial health, and everything else mixed together.

So what do you think? Are your clients still (or increasingly?) wary about the markets? And if so, is it because of the Flash Crash, or all this other uncertainty we’re facing in today’s difficult world? And perhaps more importantly, is there anything special you are doing to communicate to your clients in the face of that uncertainty?